Expansionary central bank policies act as a sedative for the markets

We have seen an increase in economic and political risk factors in recent weeks. While the consequences of the Brexit decision can only be speculated on up to now, the implications of the negative consequences are already evident in the first confidence surveys and purchasing mangers‘ indices. Political uncertainty in countries such as Spain or Portugal, where the formation of the government is a never-ending process, is being suppressed in the face of new major issues. Many investors reacted anxiously to the problems in the Italian banking sector, which prompted speculation about the necessity of another bank bailout by the state. In France and Germany, several terrorist attacks rather than economic issues are fuelling mounting uncertainty.

One might have expected that a heightened mix of risks would impact on investor sentiment and that volatility on the markets would remain high. In fact, the situation on the foreign exchange markets has eased in recent weeks. The VIX index, a highly-regarded risk barometer, has meanwhile fallen to its lowest level in a year. Safe havens such as the Swiss Franc and the Japanese Yen have forfeited some of the Brexit profits again. On a trade-weighted basis, the Euro has even climbed once more to its highest level since April.

The calmer markets were attributable to a large degree to important central banks predicting further quantitative easing measures. Although the Brexit decision did not result in hasty reaction, there is meanwhile scarcely any doubt that money supply will be increased somewhat further. After the Japanese central bank expanded monetary easing further last Friday, the Bank of England is next in line on Thursday to support the economy with the rate cut that has already been predicted. Market participants expect the ECB will prolong the QE programme or indicate its intention to take a more expansionary monetary-policy tack on September 8. The US Federal Reserve will not pursue a more expansionary policy, but monetary policy normalisation has been put on hold for the time being.

However, the central banks are not the only sedatives for the markets. Renewed political crises in the Eurozone will quickly evoke memories of last year’s successful Greek rescue. The fear of dramatic political distortions is being suppressed by a natural acclimatisation effect that is fuelled by the faith in the effectiveness of political regulatory measures.

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